Victory for Arctic Systems Ltd at the Court of Appeal

Geoff Jones of Arctic Systems Ltd had appealed to the Court of Appeal against the decision in the High Court to uphold the Inland Revenue's contention that the payment of dividends to Mr. Jones's wife fell foul of the Settlements Legislation (Section 660A). All three judges hearing the appeal decided that the Revenue's case was incorrect, on two major principles.

The appeal was heard on 29 and 30 November 2005, before the Chancellor of the High Court, Sir Andrew Morritt, Lord Justice Keane, and Lord Justice Carnwath. The unanimous judgement was delivered on 15 December 2005. None of the judges found any merit whatever in the Revenue's application of the Settlements Legislation to Mr. and Mrs. Jones's case. This can rightly be seen as a landmark victory for small businesses, and for common sense.

Settlement
The Court of Appeal decided that the arrangement whereby Mrs. Jones owned a share in the Company and received dividends, irrespective of her contribution to the trading activities of the Company, was not in itself a "settlement" within the meaning of the legislation. Sir Andrew Morritt pointed out that although Mr. Jones controlled the Company, which gave him an ability to confer benefit upon his wife, the other shareholder, this arrangement did not in itself confer any benefit. Mr. Jones's decisions about the levels of salary and dividends to be paid to himself and to his wife were not part of a settlement. He said: "They did not form any part of a structure of things .... their uncertainty and fluidity is the converse of an arrangement .... No doubt Mr. and Mrs. Jones hoped for the best but it cannot be said that they had arranged it .... I am unable to accept that the payment of modest salaries to Mr. Jones was any part of the arrangement. Similarly the declaration of the dividends was not arranged in advance; it was dependent upon the trading fortunes of the Company".

Lord Justice Keane also referred to the existence of uncertainty at the time the Company was established, with specific regard to the levels of salary and dividends that might be paid in the future. He said: "It is difficult to regard such a protean state of affairs as capable of being part of an arrangement in the sense used in the legislation".

Bounty
The Court of Appeal also disagreed with the Revenue's contention that the payment of dividends to a spouse who was not the main fee earner was "bounteous". Sir Andrew Morritt said: "Though one spouse may generate the income of the firm or company, the services of the other may be just as commercially important in providing the essential administrative, accounting, support and backup services". Mr. Jones's ability to control the Company was not bounteous. The fact that at some stage some mitigation of tax liability might arise was irrelevant to the existence of an element of bounty. Lord Justice Keane agreed that the element of bounty was "too speculative when viewed as at the date of the alleged settlement".

Revenue's Interpretation
For his part, Lord Justice Carnwath was concerned about the lack of clarity in the statute and the Revenue's interpretation of it. He underlined the "need for caution in extending the concept of settlement beyond the scope of existing jurisprudence". He felt that the Revenue were taking things too far. "For the first time, they seek to apply the concept to what has been found to be a normal commercial transaction between two adults, to which each is making a substantial commercial contribution, albeit not of the same economic value. Such a difference, by itself, is not enough to my mind to take the arrangement into the realm of "bounty", as it has been understood in the existing cases. If the legislature wished such an arrangement to be brought within a special regime for tax purposes, clearer language is necessary to achieve it".

There is a possibility that the Revenue might appeal to the House of Lords. Hopefully they will clarify their intentions soon.

Articles by Keith Preece - Qdos Consulting

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Posted 23/12/05

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